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In-Depth: Squeezed supply chains lead to rise in inflation

Pandemic impacts prices as supply chains rebound
On The Money-NerdWallet-Emergency Fund
Posted at 7:12 PM, May 05, 2021
and last updated 2021-05-05 20:12:06-04

KANSAS CITY, Mo. — It’s a natural reflex for the U.S. economy to get more nervous when the cost for goods and services begins to rise more quickly.

Inflation can be a boogeyman of sorts, threatening to diminish the buying power of money.

While an annual rate of 2% inflation is generally considered a good sign for the economy’s health, the latest Midwest Consumer Price Index report, which showed a 3% jump in year-over-year inflation, garnered understandable attention.

Inflation surged 0.7% in February to March 2021, but economists aren’t ready to say it’s a signal of trouble ahead.

“With the March release, we did see a big bump, going up to 3%, but that was primarily due to energy costs, which we all know how those fluctuate,” Cheryl Abbott, regional economist for the Bureau of Labor Statistics Southwest and Mountain Plains regions, said.

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The record cold snap, which crippled the energy grid in Texas and sent natural gas spiraling up, represents a big chunk of the March inflation numbers.

Natural gas service rose 14.8% in March compared to a year earlier.

Gas prices also are up significantly — 29.3% since March 2020 — although that has a lot to do with recent OPEC production cuts, which begin rolling back this month.

Abbott said the 3% spike in the Midwest Consumer Price Index was above the national average, which was 2.6%, but the price inflation in food prices, for instance, actually lagged behind the national average.

“How concerned should they be really depends on the type of goods and services that they purchase,” Abbott said. “We are definitely seeing a tick up in inflation in certain goods. As far as commodities are concerned, items like refrigerators are seeing 10% increases, so that’s a pretty stout rate of increase over the year.”

Among the non-energy goods and commodities seeing the largest price increase:

  • Fruit and vegetable prices were up 4.2% over March 2020;
  • Meat, poultry, fish and eggs were up 3.4%;
  • Used vehicles were up 9.9%.

Lumbering economy?

Of course, each of those pales in comparison to the lumber market, which has more than doubled its previous record-high trading prices since last summer.

Typically, lumber has traded in the $300 to $500 range per board-foot for decades, according to Stinson Dean.

When the lumber supply tightened last summer, the lumber reached record territory in July and kept climbing. Prices reached $1,000 by late last summer and still haven’t stopped climbing, reaching $1,600 on Tuesday afternoon.

According to Dean, who owns Deacon Lumber and is a lumber trader, the COVID-19 pandemic alone doesn’t explain the surging prices, but it did force the massive uptick into overdrive.

The most common framing lumber used in U.S. homebuilding is Canadian spruce, which is easier to work with than domestically abundant southern yellow pine, Dean said.

Concerns about over-logging prompted the Canadian government, which owns most of the nation’s timberland, to scale back production by cutting annual allowable cut in 2017.

That led to decreased supply, but demand was low amid a soft housing market, especially in 2019.

Low lumber prices coupled with a 23% tariff the Trump administration slapped on Canadian lumber actually forced many Canadian sawmills, which process the cut timber in boards used for construction, out of business.

When the housing market boomed and do-it-yourself projects ramped up amid stay-at-home orders early in the pandemic, the existing supply was quickly exhausted and there was no way for Canada to ramp up production with fewer sawmills and caps on logging.

“(With) the structural changes in the Canadian log supply, I think we would have gotten here eventually,” Dean said of the record lumber prices. “We got here in a hurry, because of the COVID dynamics.”

Lowe’s, Home Depot and Menard’s continue to sell plenty of lumber, but it has squeezed the non-retail market sector, especially for homebuilders, and added an estimated $36,000 to the cost of a new home.

Inflated inflation worries

Dean thinks the inflated lumber market will remain at record levels long after other commodities normalize as supply chains begin to catch up and crank out inventory, but other goods — semiconductors and some types of food — remain strained right now.

“It’s all demand driven ...,” Dean said. “We see the headline inflation number, but you’ve got to take that relative to the buying power of the individual, which is significantly higher right now.”

While he understands the concern about inflation, Dean suggested that the spikes for lumber and some other goods shouldn’t be overly worrisome given the demand.

“There’s more cash in more people’s pockets than we’ve seen in generations,” Dean said. “If you look at the Census data, the savings rate are almost off the charts for Americans due largely to stimulus and (Paycheck Protection Program) loans and people staying on payroll. So, there’s a lot of cash. It also means people can afford more expensive things.”

Once production ramps back, Dean expects prices for most commodities will level off. That may be especially true if the federal bank is done pumping stimulus money into the economy by giving cash directly to low- and middle-income families.

“We’ve never had a recovery like this,” Dean said, “We’ve never had the federal bank inject so much cash so broadly. No one really knew what to think.”

Abbott agreed. It’s too early to say there’s absolutely no inflation risk, but there’s also no reason to wring hands quite yet despite some of the volatility.

“Exactly what that’s going to do to the overall inflation picture, we’re going to have to wait and see,” she said.